Categories That Rely On Discretionary Income Could Be Hurt Significantly By the Effects of the Fiscal Cliff

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Not without good reason has the term "fiscal cliff" been the
buzzword of post-election 2012. After experiencing tax cuts in 2001, 2003 and
2009, Americans are now faced with the impending expiration of more than 80
payroll and income tax breaks if Congress fails to reach a budget deal by the
end of 2012.

The measures would be aimed at lowering the federal government's
deficit, which has exceeded $1 trillion in each of the past four years. About
two-thirds of the proposed revenue-generating policies are based on taxes, a
hot topic that has erected an impasse in Washington.

The expirations could bump up the average household's income tax
rate by about five percentage points, according to the Tax Policy Center. Some households, particularly those
that file jointly and earn between $60,350 and $72,350, may even be looking at
as much as a 13 percentage point increase in 2013.

Without a doubt, nearly all Americans will see the effects of the
fiscal cliff in their wallets. A complete elimination of recent tax cuts could
lead the nation to a double-dip recession, as consumers significantly reduce their
spending and create a drag on GDP.

In the event that an alternative does not emerge, IBISWorld has
examined the potential impact that the fiscal cliff would have on the nation's
economy, particularly focusing on tax cut expirations and their effects on
specific U.S. industries.

By tracking industry performance during the past five years and
benchmarking sectors' revenue volatility against changes in per capita
disposable income, IBISWorld has determined the three sectors that will be most
severely hurt by the tax increases resulting from the looming fiscal cliff and
its likely chokehold on disposable income.

Automotive

Cars are highly discretionary and expensive purchases that require
significant maintenance, so a reduction in disposable income would force
consumers to delay new purchases over the next couple of years. As such,
industries operating in the automotive sector that are particularly sensitive
to changes in personal income include car dealerships, gas
stations and car service providers (e.g. car wash and auto detailing).

During the five years to 2012, this sector has endured an
aggregate 3.1% average annual decline in revenue due to the luckless
combination of falling disposable incomes and increasing prices. In 2008,
sector revenue plunged 7.1% when the world price of crude oil shot up more than
35.0%. Although in 2009 the price of oil came back down, sector revenue
continued to plummet as per capita disposable income dropped 3.6%,

The automotive sector's high sensitivity to consumers' purchasing
power ultimately resulted in high revenue volatility during the past five
years. Based on the sector's recent performance, IBISWorld expects it to be one
of the US economy's worst-hit victims if the
fiscal cliff is not resolved by the end of 2012. This, on top of already-high
and volatile gas prices, could severely hurt the auto sector during the five
years to 2017.

Apparel

The apparel retailing sector of the US economy is also projected to suffer if
the tax cuts get repealed at the onset of 2013. Since 2007, revenue for this sector
(which includes women's clothing stores, shoe stores and department
stores, among others) has declined at an average annual rate of 2.3% due to
declining disposable income and, consequently, falling demand. Its revenue
volatility has been slightly less drastic than that of the auto sector, but
still highlights the segment's dramatic annual fluctuations.

In 2008, 2009 and 2010, revenue declined by 6.7%, 5.7% and 0.5%,
respectively, reflecting consumers' unwillingness to part with their limited
funds for nonessential clothing. If consumers again lose their impetus and
financial capacity to shop for clothing due to the expiration of tax cuts under
the fiscal cliff, industries in this sector, especially those supplying
high-end and high-priced clothing, will suffer in the next year.

By contrast, those selling essential items, like babies' and
children's clothes, will be less affected because demand for these items is
based more on need rather than keeping up with trends.

Entertainment

Entertainment is another area that is highly sensitive to
fluctuations in consumer spending power. Included in this sector are industries
such as museums, casino hotels and golf courses and country clubs.

Because many of these activities are luxuries rather than necessities,
consumers are quick to cut them out of their budgets once per capita disposable
income begins to decline. As a result, this sector's revenue has shrunk at an
average annual rate of 0.1% during the past five years - a rate the masks
dramatic fluctuations over the period.

Highlighting its widely perceived nonessential nature, sector
revenue was declining in 2008 even before disposable incomes dropped, due to
crashing consumer confidence. A rebound in consumer spending power has not
completely revived this economic segment, which foreshadows its deep potential
drop if tax breaks are not revived at the end of 2012.

Uncertain road ahead

If the effects of low disposable income during the Great Recession
are any indication of what the fiscal cliff has in store, these sectors should
start bracing for some major challenges in the years ahead.

With recessionary struggles still fresh in the mind of many
Americans, this blow to disposable income is all it will take to send consumer
sentiment crashing again. Should tax rates increase by 5.0 percentage points
for the average household, and even up to 13.0 percentage points for some,
budgets will tighten and demand for nonessential products will fall.

While the reach of the fiscal cliff would go beyond the sectors
outlined above, its impact would be especially detrimental to businesses
operating within these segments due to their sensitivity to household
disposable income and poor performance during the recession.

This, however, all depends on whether or not Congress and
President Obama can reach a viable agreement that will prevent the expiration
of several tax breaks that were initiated during the past decade.

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